The U.S. Supreme Court yesterday unanimously rejected application of the “discovery rule” approach to extending the statute of limitations for SEC enforcement actions. The Court held in Gabelli v. SEC that the SEC must seek civil penalties within five years after the alleged conduct occurred, rather than within five years after the SEC discovered (or could have discovered) it. The decision is a victory for those subject to SEC investigations because it provides greater certainty, and a shorter time frame, for when the SEC must act.
The statute of limitations governing SEC requests for civil penalties provides that any action “for the enforcement of any civil fine, penalty, or forfeiture . . . shall not be entertained unless commenced within five years from the date when the claim first accrued.” 28 U.S.C. § 2462. The SEC argued that claims first accrue when the agency discovers or could have discovered an alleged fraud. The Court rejected that argument, holding that the SEC must file its charges within five years after the alleged conduct is complete.
The defendants in Gabelli were investment advisor Gabelli Funds LLC and its chief operating officer and portfolio manager. The SEC alleged that the individuals allowed an investor in a mutual fund managed by the advisor to engage in market timing, which is the practice of after-hours trading in the mutual fund’s securities at the prior day’s prices and which is harmful to other long-term investors in the fund. During the relevant period, the market timing investor earned 184% returns while long-term investors’ returns were negative.
The SEC alleged that the market timing ceased in August 2002 but that the SEC did not discover the fraud until late 2003 because of the secret nature of the defendants’ wrongdoing. The SEC filed its complaint in April 2008, which was within five years of the time the SEC alleged that it discovered the fraud but more than five years after the time the SEC alleged the fraud ceased.
Chief Justice Roberts, writing for all nine Justices, rejected the SEC’s request to elongate the limitations period and held the SEC to “the ‘standard rule’ [] that a claim accrues when the plaintiff has a complete and present cause of action.” Gabelli, slip op. at 5 (citation omitted). A plaintiff has a complete and present cause of action once the wrongful conduct is complete.
The discovery rule that the SEC sought to apply is an exception to that standard rule, but, the Court noted, has never been applied beyond the context of a private litigant who did not discover a fraud committed against him personally and for which he sought recompense. The Court held that the SEC’s very purpose is to discover fraud and therefore it does not require the same protections: “Unlike the private party who has no reason to suspect fraud, the SEC’s very purpose is to root it out, and it has many legal tools at hand to aid in that pursuit.” Id. at 8. The Court also expressed reluctance to require lower courts to determine when exactly a government agency should be held to have discovered something, given the varying persons, priorities, and resources available at any given agency. Id. at 11.
The Gabelli decision gives certainty to those facing SEC enforcement actions that they can now know when the government’s time is up.
The Court’s unanimous decision, and the questions of some Justices at oral argument, also signaled that the Court may be placing a watchful eye on the SEC’s conduct in its investigations. As a civil enforcement agency, the SEC can employ certain enforcement tools that have the ability to exert extreme leverage on the targets of its investigations. For example, the SEC and other civil government agencies can obtain an adverse inference against a party that asserts its Fifth Amendment right not to testify; subject defendants to double jeopardy; litigate against an unrepresented party that can’t afford a lawyer without contravening the Sixth Amendment; and may impose excessive fines free from the confines of the Eighth Amendment. With certain amendments in the Dodd-Frank Act, the SEC can now impose civil penalties in administrative proceedings, free from the review of the judicial branch and safely within the confines of an executive agency whose commissioners are statutorily protected from oversight by other branches of government.
At oral argument, Justice Breyer characterized the SEC’s investigation, which was no different from hundreds of other proceedings in which it seeks civil penalties each year, as “close to a criminal case,” “quasi-criminal,” and involving something that “look[s] like criminal penalties.” Justice Scalia called the SEC’s case a “prosecution” and asked the SEC whether the rule of lenity— a doctrine applied in criminal cases that requires all legal ambiguity to be resolved in the defendant’s favor— should apply in the SEC’s case. Justice Scalia also questioned why the SEC does not have to adhere to the same standard of proof as in a criminal case, saying “[y]ou just call it a civil penalty and you don’t have to prove it beyond a reasonable doubt . . . .”
This line of questioning leaves open the possibility that the Supreme Court may be open to arguments that the SEC should be held to a tougher standard than private civil litigants.
The full text of the opinion can be read here.
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This advisory was prepared by Ian Roffman, a partner in the Securities Enforcement and Litigation practice group, and Jonathan R. Allen, an associate in the practice group. For more information, please contact Ian or your Nutter attorney at 617.439.2000.
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